Asia Entertainment & Resources: Ready to Cash Out

While we mostly follow the consumer sector, we wanted to share Asia Entertainment & Resources (AERL), a stock which provides us China exposure but with a twist.

Asia Entertainment & Resources has advanced 8% over the past week and looks to be moving higher. AERL operates two VIP gaming rooms in Macau, China, which is the largest gaming market in the world. Currently AERL is in the MGM Grand Macau Casino and a luxury 5-star hotel, the Star World Hotel & Casino.

After the acquisition of the VIP room in the Venetian (Macau), which was announced in October, AERL is now projected to see a monthly rolling chip turnover in excess of US$1 billion. This would equate to roughly US$4.6 million in net income per month to the company or US$55 million per year.

We believe after the dust settles on the warrants that were exercised last week that the company will have roughly 25 million shares outstanding and would imply an annual EPS of US$2.20. At 10x, AERL would be valued at $22 per share vs. todays closing price of US$5.47.

Why AERL may be positioned to move upward:

Warrant overhang is out of the way this week and we believe AERL will exceeded their initial target of $25 million in conversion. This cash infusion would fund the Venetian project and leave ample working capital on the balance sheet for additional acquisitions or upgrades to existing facilities. We expect further clarification shortly as the warrants expired on 10/28/10 and note they were at $5. This explains why the stock has remained around $5 till the last few trading days.

While we are not excited about investing in China right now due to the fraud overhang head lines, we note that AERL is subject to frequent audits based on the gaming regulators. Having Uncle Charlie making sure he gets his fair share provides some additional oversight that most China equity investments can not provide.

We love the macro story in Macau right now. Growth in gaming revenue in Macau has gone from US$6 billion in 2005 to US$15 billion in 2009. Macau is the only legal casino market for Greater China and offers proximity advantages to a boat load of people - China, Japan, Korea, etc.

After the acquisition of the VIP room in the Venetian (Macau), AERL is now projected to see a monthly rolling chip turnover in excess of US$1 billion. This would equate to roughly US$4.6 million in net income per month to the company or US$55.2 million per year. We believe after the dust settles on the warrants that were exercised last week, at 25 million shares outstanding AERL could generate annual EPS of US$2.20. At 10x, AERL would be valued at US$22 per share vs. todays closing price of US$5.47.

Recent news:

October 21 - AERL announces that the first 15 days in October experienced 86% growth in Rolling Chip Turnover. This equates to US$658 million and is more than they did for entire month of October 2009.

October 15 - AERL announces 3Q10 results with revenue at US$28.5 million, +105% to LY. EPS was US$0.40 vs a loss the prior year. Guidance for Rolling Chip Turnover for FY10 is expected to be around US$8.6 billion compared to US$5.2 billion last year.

October 12 - AERL announces non-binding agreement for VIP room in the Venetian that hosts 5 tables. Average Rolling Chip Turnover at this facility has been HK$1 billion or roughly US$129 million per month with a 1.25% commission over the last six months.

The risks in AERL range from the over 150 gaming promoters for 180 rooms in Macau to China travel restrictions to Macau. Tourists from China account for over 50% of the traffic to Macau. We also worry about legalized gambling in other countries such as Malaysia, Vietnam, S. Korea and others. A general macro slowdown in the greater China economy could also impact gaming and traffic to Macau.